Hire Purchase and Leasing

keithy1978keithy1978 Feels At HomeRegistered Posts: 36
Hi Guys/Gals,
My mind has gone blank!
I understand the difference between Hire Purchase and Leasing but what is the accounting treatment?

For HP is it an expense in the P/L and does not get listed as an asset until ownership is acquired, similarly for Leasing it is listed as an asset with depreciation applied and payments from the P/L?

Comments

  • HayleyMHayleyM Feels At Home Registered Posts: 63
    Hi,

    I think it is as below:

    Finance & Operating leases - the legal ownership remains with the lessor. Therfore you DR P&L account with the leasing payments that you pay to the lessor and CR the lessor account. There is nothing recorded in the balance sheet as you do not capitalise assets under these leases.

    Hire Purchase Agreement - At the end of the HP period, ownership of the asset usually passes from the finance company to the business. Therefore it is treated as a capital cost. The final account show:

    In the balance sheet:
    Cost of asset capitalised
    Provision for depreciation
    Liability to lessor for capital amount of fixed asset split between long term & current liabilities

    In the profit & loss account:
    Depreciation of fixed asset
    Interest due for the year to lessor

    Hope this helps!

    If I am wrong, can someone please let me know? :001_smile:

    Good luck :thumbup1:
  • Mog17Mog17 Feels At Home Registered Posts: 91
    HayleyM wrote: »
    Hi,

    I think it is as below:

    Finance & Operating leases - the legal ownership remains with the lessor. Therfore you DR P&L account with the leasing payments that you pay to the lessor and CR the lessor account. There is nothing recorded in the balance sheet as you do not capitalise assets under these leases.

    Hire Purchase Agreement - At the end of the HP period, ownership of the asset usually passes from the finance company to the business. Therefore it is treated as a capital cost. The final account show:

    In the balance sheet:
    Cost of asset capitalised
    Provision for depreciation
    Liability to lessor for capital amount of fixed asset split between long term & current liabilities

    In the profit & loss account:
    Depreciation of fixed asset
    Interest due for the year to lessor

    Hope this helps!

    If I am wrong, can someone please let me know? :001_smile:

    Good luck :thumbup1:

    Hi Hayley, thanks for that. I was wondering how you'd deal with HP stuff in terms of capitalising etc as there isn't anything on it in my study text at all!!!
  • Bookworm55Bookworm55 Trusted Regular Registered Posts: 479
    No, sorry. You've made a small but crucial mistake.
    Finance & Operating leases - the legal ownership remains with the lessor. Therfore you DR P&L account with the leasing payments that you pay to the lessor and CR the lessor account. There is nothing recorded in the balance sheet as you do not capitalise assets under these leases.

    Operating leases work that way. Finance leases do not. You are right in that legal ownership remains with the lessor in both cases. But the accounting procedure for finance leases is as though the lessee owened the asset.
    Hire Purchase Agreement - At the end of the HP period, ownership of the asset usually passes from the finance company to the business. Therefore it is treated as a capital cost.

    That's right. A Hire-Purchase agreement is an example of a finance lease. All finance leases are accounted for like that. I don't remember how much detail you need for AAT, but it looks a bit like this:

    Capitalise the asset
    Depreciate it over its useful life

    Capitalise the liability
    Reduce it over the life of the asset as repayments are made

    P&L will have depreciation and payments to the lessor.

    Effectively what you're doing is accounting for two transactions: purchasing an asset (and its subsequent depreciation) and taking out a loan (and its subsequent repayments).
  • jewels.pjewels.p Font Of All Knowledge Registered Posts: 1,774
    Bookworm55 wrote: »
    No, sorry. You've made a small but crucial mistake.



    Operating leases work that way. Finance leases do not. You are right in that legal ownership remains with the lessor in both cases. But the accounting procedure for finance leases is as though the lessee owened the asset.



    That's right. A Hire-Purchase agreement is an example of a finance lease. All finance leases are accounted for like that. I don't remember how much detail you need for AAT, but it looks a bit like this:

    Capitalise the asset
    Depreciate it over its useful life

    Capitalise the liability
    Reduce it over the life of the asset as repayments are made

    P&L will have depreciation and payments to the lessor.

    Effectively what you're doing is accounting for two transactions: purchasing an asset (and its subsequent depreciation) and taking out a loan (and its subsequent repayments).

    I didnt know that you treated it as a loan too. I thought that you just Capitalised it. Thats something I wouldave missed out!:crying:
  • HayleyMHayleyM Feels At Home Registered Posts: 63
    Hi,

    Sorry you are right... I just check my text book. There is a really good diagram on all the leases on page 171 osbourne books (tutorial unit 5) - Hope this helps everyone.

    Is this likely to appear in the exam?

    Ta
  • safricasafrica Well-Known Registered Posts: 106
    HayleyM wrote: »
    Hi,

    Sorry you are right... I just check my text book. There is a really good diagram on all the leases on page 171 osbourne books (tutorial unit 5) - Hope this helps everyone.

    Is this likely to appear in the exam?

    Ta

    Thank you for that, very helpful ! :thumbup1:still hope it doesn't come up this afternoon !!
  • jewels.pjewels.p Font Of All Knowledge Registered Posts: 1,774
    safrica wrote: »
    Thank you for that, very helpful ! :thumbup1:still hope it doesn't come up this afternoon !!

    Me too. :thumbdown:
  • Bookworm55Bookworm55 Trusted Regular Registered Posts: 479
    Will it be on the exam? It can be and it has but not every year. It wasn't tested last time. I dislike 'gaming' exams (as in "this topic wasn't tested last time, and so will be tested this time"), and I don't think it's a major focus of the unit. Compared to depreciation and stocks, which always come up. I wouldn't like to gamble on it not being tested.
    I didnt know that you treated it as a loan too. I thought that you just Capitalised it. Thats something I wouldave missed out!

    Well, the accounting entries for this are actually quite tricky. I would have thought it too complex for an Intermediate unit, and I don't know if it would come up again on DFS. The only times I've seen it tested it's been as a memo explaining the difference between finance and operating leases.

    When I say you treat it as a loan, I mean almost. You capitalise the asset and create a capitalised liability of the total payments under the lease. Because that's what you're doing for almost all practical purposes. Even though the asset belongs to the lessor, the lessee has almost full control for all of its useful life, so the accounting treatment is as though the lessee financed the lease with a loan. It's not quite the same thing, but you do have a non-current asset and a non-current liability.
  • HayleyMHayleyM Feels At Home Registered Posts: 63
    [QUOTE

    When I say you treat it as a loan, I mean almost. You capitalise the asset and create a capitalised liability of the total payments under the lease. Because that's what you're doing for almost all practical purposes. Even though the asset belongs to the lessor, the lessee has almost full control for all of its useful life, so the accounting treatment is as though the lessee financed the lease with a loan. It's not quite the same thing, but you do have a non-current asset and a non-current liability.[/QUOTE]

    So it's like getting a bank loan and buying a car...sort of?

    You own the car but still owe the bank the money.
    So you have the car in the fixed asset account and depreciate it every year as normal. The loan then appears on the balance sheet as a liability and the car and depreciation in the fixed assets section.
    Then in the p&l account you have the depreciation charge per year and the interest payments in the overheads section. :001_smile:

    Is this right?

    Thanks
  • Bookworm55Bookworm55 Trusted Regular Registered Posts: 479
    Pretty much spot on. Although you're only doing one transaction (the hire purchase) there's really two things to deal with: purchase of the asset and the financing to pay for it.

    You're going to be making capital repayments (not interest payments) every year, so the liability gets smaller as the NBV of the asset hets smaller. There's a slight complication in that you get a 'finance charge' rather than a true interest rate. The finance charge is the difference between the list price of the asset (which is what you capitalise the asset at) and the sum of all the lease payments (which is what you capitalise the liability at). The depreciation, finance charge and loan repayments all go to the P&L. But I'm sure that's far more detail than you need.

    Good luck if you're doing the exam today!
  • HayleyMHayleyM Feels At Home Registered Posts: 63
    Bookworm55 wrote: »
    Pretty much spot on. Although you're only doing one transaction (the hire purchase) there's really two things to deal with: purchase of the asset and the financing to pay for it.

    You're going to be making capital repayments (not interest payments) every year, so the liability gets smaller as the NBV of the asset hets smaller. There's a slight complication in that you get a 'finance charge' rather than a true interest rate. The finance charge is the difference between the list price of the asset (which is what you capitalise the asset at) and the sum of all the lease payments (which is what you capitalise the liability at). The depreciation, finance charge and loan repayments all go to the P&L. But I'm sure that's far more detail than you need.

    Good luck if you're doing the exam today!
    Thanks!! I have cracked this now!! You are a star!

    Yes, I am sitting it today so thanks. Good luck for you as well if you are!!
  • jewels.pjewels.p Font Of All Knowledge Registered Posts: 1,774
    Bookworm55 wrote: »
    Will it be on the exam? It can be and it has but not every year. It wasn't tested last time. I dislike 'gaming' exams (as in "this topic wasn't tested last time, and so will be tested this time"), and I don't think it's a major focus of the unit. Compared to depreciation and stocks, which always come up. I wouldn't like to gamble on it not being tested.



    Well, the accounting entries for this are actually quite tricky. I would have thought it too complex for an Intermediate unit, and I don't know if it would come up again on DFS. The only times I've seen it tested it's been as a memo explaining the difference between finance and operating leases.

    When I say you treat it as a loan, I mean almost. You capitalise the asset and create a capitalised liability of the total payments under the lease. Because that's what you're doing for almost all practical purposes. Even though the asset belongs to the lessor, the lessee has almost full control for all of its useful life, so the accounting treatment is as though the lessee financed the lease with a loan. It's not quite the same thing, but you do have a non-current asset and a non-current liability.

    You're good at this!:laugh:
  • jewels.pjewels.p Font Of All Knowledge Registered Posts: 1,774
    Hey Bookworm55 you seem to know a lot. What do I do if my ETB Columns dont balance in the Exam. (They never have on the Past Exam Papers) Should I open a Suspense Account or is that only for the Trial Balance?

    Thanks

    Julie:001_smile:
  • Bookworm55Bookworm55 Trusted Regular Registered Posts: 479
    You're welcome, Jewels and Hayley.

    I should point out that I did FRA in June 2006...

    If the columns don't balance, then you could put a suspense account in. It's usually easier to spot the mistakes in an ETB because you have the adjustments columns right in front of you. If I had time, I'd leave it and come back to look for the mistake at the end of the exam. If I was running out of time, I would probably just put it in a suspense account.
  • shonrhysevansshonrhysevans Just Joined Registered Posts: 3
    Bookworm55 wrote: »
    Pretty much spot on. Although you're only doing one transaction (the hire purchase) there's really two things to deal with: purchase of the asset and the financing to pay for it.

    You're going to be making capital repayments (not interest payments) every year, so the liability gets smaller as the NBV of the asset hets smaller. There's a slight complication in that you get a 'finance charge' rather than a true interest rate. The finance charge is the difference between the list price of the asset (which is what you capitalise the asset at) and the sum of all the lease payments (which is what you capitalise the liability at). The depreciation, finance charge and loan repayments all go to the P&L. But I'm sure that's far more detail than you need.

    Good luck if you're doing the exam today!
    HP repayments are not charged to the P&L, only the interest element (finance charges). The capital element of the repayment is debited to the HP account on the balance sheet to lessen the liability.
  • Gem7321Gem7321 Experienced Mentor DevonMAAT, AAT Licensed Accountant Posts: 1,438
    Bookworm55 wrote: »
    The depreciation, finance charge and loan repayments all go to the P&L.

    No, the loan repayments go against the loan account in the balance sheet to reduce the liability.

    Edit: Sorry Shon didn't see your earlier post!
  • PinchyPinchy Feels At Home Registered Posts: 38
    Hey,

    I was told by my tutor that HP's are not on the syllabus anymore so I didn't revise them and they never came up. Hope that helps! :ohmy:
  • Bookworm55Bookworm55 Trusted Regular Registered Posts: 479
    And I apologise for making an honest mistake with saying the capital repayments go through the P&L. Clearly that is what I said, but it's wrong. I probably should have spotted that myself, but thanks for bringing it to my attention.

    If you would like to point out all the other mistakes I made if you strike out the words 'and loan repayments' from the penultimate sentence, please feel free to do so.

    Also, thanks to ShonRhysEvans for sending me a PM telling me to keep my mouth shut rather than make a mistake. It's nice to know that there is now someone infallible on the boards.
  • shonrhysevansshonrhysevans Just Joined Registered Posts: 3
    Bookworm55 wrote: »
    Also, thanks to ShonRhysEvans for sending me a PM telling me to keep my mouth shut rather than make a mistake. It's nice to know that there is now someone infallible on the boards.

    This is the exact PM i sent Bookworm55:

    "If you aren't sure of the answer to a question it's better to say nothing rather than give an incorrect answer. The HP repayments don't hit the p&l at all."

    There is no mention of the words "keep your mouth shut".

    I believe that answering questions incorrectly complicate the issue and confuse the person who originally asked the question even more so.

    I am far from infallible; but when I don't know the answer to a question I don't hazard a guess.
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